Rent-To-Own Dos and Don'ts

In 2001, fresh on the heels of a divorce and with a less-than-desirable credit rating, I was in the unenviable position of being homeless. A single mother with a half dozen children in tow is not the most welcome tenant and, with little money for a down payment, obtaining a conventional mortgage (even in the freewheeling loan days of a few years ago) was out of the question.

While temporarily renting a house from a friend, I sought to purchase a home with owner financing. What I ended up with was, for me, the best of the real estate renting and purchasing worlds - a contract to lease with an option to buy, also known as a rent-to-own contract.

With a $5,000 option fee and an additional $200 of my monthly $1,200 rent going towards my down payment, I had an $8,600 credit from the seller going into closing. In the meantime, I had the opportunity to live in the house and have repairs covered by the landlord (seller) during my 18-month rental period. (This was an especially important factor for me as I was buying an 80-year old house that had recently been rehabbed.) As a result, the house was in better condition when I bought it than when I initially moved in - and those repairs didn't cost me a dime.

While my experience went rather smoothly, the process is not without pitfalls. Here's my list of do's and don'ts to consider when contemplating a rent-to-own contract.

Do's

Research the seller. In my case, the seller was an experienced home renovator who bought houses, rehabbed them, and sold them. He not only leased several other homes in my neighborhood, he lived there himself - less than two blocks down on my street. This meant he had a vested interest in keeping property values high and was conscientious in his renovations. He also had a good reputation among our neighbors, previous buyers of his properties, and with local real estate professionals - always a good sign.

Research the community. Just because a seller sets a specific price does not mean the house warrants that price. There are several on-line sites to research market values. In some areas, government property appraiser websites provide comparable (and reliable) sales figures.

Consider property value trends. At the time I purchased my home, housing values in the Tampa, Florida, area were on the rise. As a result, my home had increased in value between the time I first contracted to lease the home and my closing date. If property values are declining, you may be locked into purchasing a home for far more than its fair market value. This may put you at a severe disadvantage if you are trying to obtain a conventional mortgage at the end of the lease.

Make sure the contract is clear on the details. Some specific points to address:

What happens at the end of the contract? Can the buyer walk away at the end of the lease period (forfeiting his option fee) or is he obligated to buy the home regardless?

Can the lease period be extended? If the buyer cannot secure financing at the end of the original lease period, can he purchase an extension with (or without) an additional option fee? In reverse, is there a penalty for closing on the house before the lease period has expired?

Who is responsible for maintenance? My seller took care of all repairs during my rental period, but this should be spelled out in the contract. (It is not uncommon for renters to be responsible for normal lawn maintenance even if repair work and general maintenance is covered by the owner, but, again, this should be clear in the contract.)

Is the buyer's option transferrable? If the buyer cannot exercise the option personally, can he sell it to someone else and allow them full benefits of the contract?

When are lease payments due? Due dates, grace periods, and any penalties for late payments need to be outlined in writing.

Don'ts

Assume that the contract is non-negotiable. Just because you are in a less-than-perfect purchasing position, nothing is binding until it is agreed upon by both parties. No deal is a good deal if you leave the table feeling that you were swindled.

Assume the owner's insurance policy will cover your possessions. Until the house is purchased outright, you are a tenant and should maintain your own renter's insurance policy.

Go it alone. Take advantage of the experts. Have an appraisal and a survey done. Work with a title company to facilitate closing.

Lastly, an important "Do" and a considerable "Don't":

Do consult a mortgage banker. If you are considering a rent-to-own contract because of your personal financial situation, you need to realistically evaluate whether or not you can improve your circumstances within the lease period. If you need to reach a specific credit score, can you get control of your debt to reach that goal in the time allotted? If you need a larger down payment, will you be able to save that amount within the contract period? If your goal of purchasing the home is attainable, make a plan and stick with it.

Don't feel that you are obligated to close on the home under any circumstances. One of the beauties of renting to own for the buyer is that you get a first-hand feel for the property and the neighborhood. Make sure you are happy with the schools, your neighbors, the purchase price of the house and the cost to maintain it. It may be far less expensive to walk away from your option fee and rent credit than to try to unload a home that you yourself don't love.

Happy House Hunting!